by Moneycontrol.comMauritius FII, CNBC-TV18 has learnt, have filed their tax returns this year, claiming their income to be capital gains, which means long-term capital gains is exempt, on short-term capital gains you pay tax at the rate of 10%. So, most FIIs that are non-Mauritius based, are actually filing tax returns claiming their income to be capital gains; are willing to pay 10% short-term capital gains tax. For Mauritius based FIIs, there is no tax on capital gains, because under the India-Mauritius tax treaty, they enjoy tax exemption.

But for non-Mauritius based FIIs, there was a huge controversy that erupted last year, when the CBDT issued a draft circular trying to distinguish between what is business income and capital gains.

"The ruling is clear. one can only invest, which means there is no question of business income.It also makes sense for FIIs to pay capital gains tax for tax certainty" said Sunil Kapadia, Partner, E&Y
"If you show it as business income, tax department will ask for details and if for some reason, they are able to prove that the FII has a permanent establishment in India, then they will have to pay 41% tax.So it is better to pay 10% tax on short term capital gains and avoid litigation" added TP Oswal, Chmn, Intl Fiscal Association-India.

CNBC-TV18 analysis:
Basically, if you trade in shares, it is business income.

If you invest, it is capital gains. The CBDT tried to distinguish this. There was a big controversy. But now finally it seems that the FIIs do not want any threat of litigation. If you claim your income to be business income and if you do not have a permanent establishment, there is Nil tax. But if the tax department were to prove somehow that an FII has a permanent establishment in India, the tax rate goes to 40%. So, most FIIs want to play it safe, want to actually categorise their income as capital gains. Pay 10%, not avoid the risk of actually getting caught and then having to pay 40%. So, almost 95% FIIs are actually paying tax on capital gains. The controversy is almost at its end.